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Anup Menon

Recommendation: Higher risk preference: Buy Low risk preference: Hold and cut exposures at around Rs 175-180

THE guzzle king of the breweries industry, United Breweries could be in for an interesting time in fiscal 2003. While demand pressures are not likely to be a problem, the supply-side economics could pose a challenge.

The mushrooming competition in the industry may have a negative impact on prices, especially as competitors may resort to price wars to gain market share. But given its current position in the industry and the recent strategic moves, UB's position is not under threat.The UB stock is among the most actively traded in the industry. It is among the few to have generated positive returns in the last fiscal. On a relative basis, it is fairly liquid. But, at the same time, its volatility levels are fairly high. It now trades at around Rs 125.

At current levels, the stock looks fairly valued. Investors with a medium-to-high risk profile can consider taking a long position in the stock. Investors should also consider taking a fresh look at their position at around the Rs 175-180 levels.

Market cocks a snook

Stock market interest in the breweries industry is rather limited. With the top two players in the industry — UB and Shaw Wallace — cornering the bulk of the market share, the scope for smaller companies is rather limited. UB's valuations in the near term do not seem to be in line with the fundamentals. Why?

The year 2002 has not been bad for the company. It posted a topline growth of around 15 per cent, better than the average beer consumption growth rate of around 10 per cent recorded over the past few years. Operational efficiency also improved in the same time-frame. The company pared its post-tax losses this fiscal. But for financial expenses, it could have come out of the red. As the performance was good, the stock price should have displayed some positive sentiment. But the market did not seem to take too much notice of this fact.

The UB stock has been on a downtrend after hitting a high in early January 2002. During November 2001-February 2002, the stock was volatile as news on structural changes in the company drove the price upwards. But since February, the stock has been declining. In this backdrop, the near-term valuations of the stock are not likely to be linked to fundamentals.

Weighed by industry dynamics

What should be interesting is how the industry shapes up in the medium term. The breweries industry has been going through a shake-up of sorts in the recent past. Recognising the potential market in India, several international players have evinced interest in the country. For instance, last year, South African Breweries, an international player with significant presence in the world market, began to make its moves in the market. The highlight of its campaign was the takeover of Mysore Breweries.

The southern States of Karnataka, Andhra Pradesh and Tamil Nadu are major consumers of beer. Both UB and Shaw Wallace, the first and second largest domestic players, have a strong hold in these markets. Though a smaller player, Mysore Breweries had a good brand and was a prominent player in this market. The quick acquisition of MBL by SAB should have sent the warning bells ringing for UB and Shaw Wallace. UB did not take SAB's acquisition of MBL lying down. Since then, UB has been consolidating its position in the industry, trying to outbid SAB from getting a hold of the market. For instance, UB came out with a bid for Rochees Breweries in Rajasthan to block SAB from getting hold of their capacities. But UB's main strength is the southern markets, where it has made quick acquisitions over the last few months. The acquisition of GMR Vasavi puts the UB group in a strong position in Andhra Pradesh, which is one among the largest markets in India. At the same time, it has also been consolidating its presence in Tamil Nadu through its acquisition of Empee Distilleries.

Meanwhile, SAB has been slowly but surely trying to enhance penetration in the Indian market. Within a year, the company has managed to garner a market share of close to 7 per cent. Given its deep pockets, it would come as no surprise if the company does not pursue more aggressive strategies to increase its market share.

SAB is not the only company eyeing the Indian market. Other international players such as Fosters and Heineken have also been eyeing the Indian market. With increased competition, it was imperative for UB to take the first step and build its defences even if it meant a higher cost in the near term.

UB's acquisitions in the recent past have put it in a relatively safe position at the top of the totem pole, at least for the time being. It has managed to pre-empt SAB and its domestic competitor, Shaw Wallace, from beating these acquisitions. However, the question is: When will these moves payoff.

Will they pay off ?

The acquisition spree appears to have landed UB into problems of funding, leading to a deterioration in its financial risk profile. But the financial risks might be worth it as the payoff appears good. Given that growth rates in the beer segment are good, it probably will be.

The payoff will materialise but might take a while. The rising competition in the industry made it imperative for UB to look out for ways to maintain its position. The decision to split the beer business into a new entity, UB Beer, should be considered as an important strategic move.

Given that UB's main cash driver is the beer business, it would naturally attract more interest, especially if the company is looking for infusion of funds from foreign partners. In this direction, UB has signed an MoU with international brewers — Scottish and Newcastle. If the deal involves fund infusion by the European Brewer, they would prove to be very useful for the company.

To a large extent, UB's recent acquisitions have come at the cost of its credit-worthiness. Given the rising level of debt in the balance-sheet, UB's credit-rating could come under pressure as it takes in more and more companies under its fold. But the foreign partner infusing some funds should give UB some more breathing space. Also, the delinking of the beer business would mean that the new entity would probably get a better valuation.

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